Any tax proposal should be correctly titled as Accountants Employment Act or Financial Writer Block Elimination Act. Certified public accountants probably salivate when taking a gander at the proposal while my inbox got stuffed with instant analyses. First of all, the legislation is merely a starting point. In Mrs. Pearson’s seventh grade social studies class, she taught us appropriation bills begin in the House of Representative then go the Senate with debate along the way. The only certainty is this legislation will blow up the deficit like a feather in a hurricane.
An idea, now discarded, dramatically rolled back 401K deferral limits. On cue, my financial compadres foamed at the mouth with some labeling the proposition an attack on the middle class. American middle-income households range from around $45,000 to $120,000 with median income around $58,000. As a retirement specialist, only households in the upper end of this middle-income bracket fully fund 401k plans ($18,000 plus $6,000 over age 50 catch-up, 2017 limits). While not a great idea, it was not a savage assault on the middle class either.
My objection to the proposal is it was a con; the savings from eliminating the tax deduction was an illusion. Contributions to 401K plans are tax-deferred but are taxed when distributed. With required mandatory distributions, the government gets their cut eventually. Yes, Virginia, tax proposals are often political rather than financial.
Play along for a minute. The trial balloon (lead, actually) had a very low limit for deductions; some reports indicated less than $3,000. But if the worker could make non-deductible Roth 401K contributions to the maximum they could conceivably be in better financial shape. Roth 401K contributions, like Roth IRA contributions, have no up-front deduction but no tax liability on distributions. Instead of pushing back against the lower deduction, the financial services industry should have lobbied for a continuation of the limits for Roth 401K contributions.
Paying taxes upfront with a Roth IRA or 401K is not necessarily a bad thing. Personally, I don’t fully fund my 401k but always fund my Roth IRA. I’m likely to be in the same tax bracket when I’m retired plus there are no mandatory distributions from Roth IRAs. Due to a legal quirk, Roth 401Ks have mandatory distributions, so a transfer to a Roth IRA is critical. Roth IRAs have adjusted gross income phaseouts ($186,000-$196,000, 2017, married couples) but Roth 401Ks have no limits. Roth accounts provide the option of relocating to a state with a higher income tax and minimizing tax liablity.
A recent Harvard study found using a Roth 401K meant more retirement income. John Beshares, the lead author, told The Wall Street Journal using Roths could translate into an additional $700 per month in retirement. Thanks Senator William Roth (R-Rhode Island), we need more like you.
You can’t always get what you want, but Buz Livingston, CFP can help figure out what you need. For specific recommendations, visit livingstonfinancial.net or come by the office in Redfish Village, 2050 Scenic 30A, M-1 Suite 230.